In everything we do in life, we must have some sort of plan. You must have at the least an idea of how you are going to achieve a certain goal in mind. The same applies to forex trading. Trading can make you a millionaire if you do it right. To be able to do it right, you must have a plan.
There’s a famous saying that goes, “If you fail to plan, you are planning you fail”. In forex trading lack of a plan could be detrimental to your account and life as you may end up losing all your money. It is therefore paramount for every trader, regardless of their trading style that they have a trading plan.
In this article, we will take you through what a trading plan is, how to create a trading plan and why it is important to have a trading plan. This is something for every trader or aspiring trader out there.
What is a Trading Plan?
A trading plan is simply a series of steps, procedures, and confluences to follow before or when you are executing a trade. It contains a detailed process of how, when, and why you are going to enter into a trade. It contains information such as;
- Trading goals
- Trading style
- Risk management
- Trading confluences
- Trading expectations
A trading plan should be an extension of what you want as a trader, when you are going to work on it, and how you are going to achieve your trading goals. It should be specifically suited for you. You must create a trading system for yourself so it best reflects your interests.
Some traders use their trading plan as a contract/promise to their selves. This means that they commit to following the trading plan to the letter. Most successful traders have a trading plan and stick to it through and through.
Also read: How To Make The Best Of A Trading Journal
What is in a trading plan?
The following are some of the essentials of a basic trading plan. You can use this as a template to create your trading plan. Feel free to twist it as much as possible so it can best suit your trading needs. A good trading plan needs to have:
1. Your source of motivation
As I mentioned above, a trading plan needs to be as specialized as possible. As you create a trading plan, it is important to include your reason for trading. To spell it out in this section, you need to answer questions such as; What motivates you to trade? What are you looking to achieve as a trader? Etc.
Ideally, you want to make this section as detailed as possible for two major reasons. First, it needs to describe your source of motivation for trading. Second, you will use it as a reminder of why you started trading especially if you happen to be losing money rapidly.
2. Trading goals
You must include what you intend to achieve from trading. Is it financial freedom? Is it to learn how to trade? Are you just looking to make an extra buck? Do you intend to make trading your full-time career? How much money are you looking to make per month?
Remember your trading plan will serve as a manual for trading. For you to be able to follow the plan diligently you need to keep on reminding yourself what your expectations are.
Your trading goals will also come in handy when you need to make decisions regarding your trading system. The difference between winning trades and losing trades is preparation.
When writing your trading goals aim to be as direct and specific as possible. Include exactly what your goals are. This will help you when you are coming up with a trading strategy. The goal is to for your strategy to help you achieve your goals. Therefore, it is paramount that you clearly define them.
If I was to list down my trading goals, they would read something close to;
- Make $5000 every month.
- Learn a new strategy for scalping.
- Trade for 5 hours every day.
3. Capital Investment
A tactical trading plan should always include how much capital you are willing to spend on trading. You could set a daily, weekly, monthly, or yearly cap on the amount you wish to invest in trading. Trading is highly addictive.
The promise- or just the thought that you could make attractive sums of money from the comfort of your living room might influence you to make a poor financial decision.
Having a cap will prevent you from using money intended for other uses as trading capital. This could be funds set aside for obligations such as bills and mortgages.
Most traders make the mistake of not setting a cap for the amount they are willing to trade with. This is a disadvantage to them in several ways.
To begin with, they might not pay as much attention to trading because at the back of their mind the trading capital is unlimited. Setting a reasonable cap motivates you as a trader to avoid losing money since your capital is limited.
Secondly, they might lose a lot of money before they realize they are doing it the wrong way. This is a mistake most traders make especially when they are starting. They end up blowing out their accounts so many times and since there are blowing smaller amounts, they fail to realize the total cumulative amount lost. With a cap in investment, you limit yourself from blowing out more than a set amount of money say in a week, month or year.
4. Markets to trade
A personalized trading plan should include the various commodities, indices, or currency pairs you wish to be trading with full time. Tactical traders mostly choose to learn and focus on a few specific markets to trade. This way they can devote their time and resources to getting better at the said markets. This alone increases their chances for success.
It is therefore important to assess what markets you perform well at and narrow down on them full time. If possible, carry out a complex technical analysis to understand what moves these markets. Understand what times the market is most productive for you.
For example, in the forex market, you could choose to narrow down on EUR/USD and GBP/USD with a focus on their respective chart pattern (s). With the US Dollar as the quote currency, it would be easy to compare and contrast these two markets under different market conditions. This will give you an edge over other traders while trading these currency pairs.
5. Entry and exit rules
These are also known as confluences. There are some rules of engagement when entering or exiting a trade. They help you determine your entry and exit point. They could be anything from indicators to tried and back-tested trading strategies. They could also include various chart and candlestick patterns.
As a trader, you promise yourself not to enter a trade if all your confluences aren’t met by the financial/forex markets. An example of a confluence would be a specific candlestick pattern. For this illustration, we will use the rising star candlestick pattern.
Some traders will only enter a trade if the chart pattern has recently formed a rising star candlestick pattern. Tactical traders have several confluences that have to be confirmed before they can enter into any specific trade.
Following your entry and exit rules will help you manage several positions at a go, as well as, gauge profit target.
6. Trading style
There are various trading plans that you could use as a trader. Professional traders choose one that works for them and then they get good at it. In the long run, it is easier for them to identify entry and exit points, profit targets, and the risk management that works for their trading style.
Examples of trading styles include:
Day trading involves opening, closing, and holding trades for a day or less. This means that by the end of the day you have closed any running trades. Day traders manage several positions every day.
Scalping involves opening and closing trades in a quick time, usually just a few minutes. Traders who use this trading style aim for many small profits to be profitable. Scalping is common for traders who mostly sell securities and trade in the stock market.
Swing trading involves holding trades over a longer time. Could be anything from several days, a few weeks, or even months.
Position trading involves holding trades over the long term. Could be for several months or years with the hope that someday they will become profitable.
Remember, when creating a trading plan, we want to be as specific as possible. Therefore, we would need to include crucial technical information such as:
- Timeframes for trading.
- What indicators to use.
- Types of stops and limits to using.
- Types of tools to use
This information will help you execute your trading strategy with ease. This is because all you need to do is to take a look at the set guidelines (trading plan) and run the trades that fall within your tactical trading plans.
Whatever your trading style is it is important to include it in your trading plan and to stick to it. Your trading style could be influenced by various reasons such as; your timetable, financial situation, past performance, investment research, etc.
7. Risk management
This is a vital part of your trading plan. How to avoid and/or manage risk. Remember, money management in trading is important and will contribute to your success as a trader. Therefore, you should have a clear and well-defined way of risk management.
There are various strategies of risk management.
The 2% rule
This rule states you can only have a maximum risk of 2% of your total account size. Every trader has a set percentage of the amount they are willing to risk in a single trade. You should include this in your trading plan to ensure that you trade within a reasonable risk tolerance level.
Risk to reward ratio
Simply put this is the fixed ratio of risk and compared to the potential reward for a trade. This will help you in making all sorts of trading decisions. Having it in your trading plan will ensure that you trade within the confines of your risk to reward ratio and that you exit trades at the right point.
Record keeping is important and will help realize patterns over a certain period and specific market conditions. When making any investment decision, you can use the diary as a guideline.
9. Trading schedule
Your trade plan should include a trading schedule. This is just a set timetable of when you will be committing yourself fully to trade. Look at it like a 9-5 job. You have to be there at 9:00 am and leave no earlier than 5:00 pm.
Your schedule should also include time for upskilling and time for breaks.
Why Is It Important To Have A Trading Plan?
A trading plan is a must-have for every serious trader out there for a variety of reasons. They include:
- Trading Discipline
A trading plan will help keep you grounded as a trader. It will help keep you within the guidelines you set for yourself. As mentioned earlier, it is a contract with yourself, as it helps you keep yourself accountable.
- Money management
A trading plan includes tools and strategies for risk management and strategies for money management. This will help you grow as a trader in the long run. A trader who has a set trading plan has a far much better chance of being successful as opposed to one who just trades without a plan.
- Time management
Successful trading requires a serious approach to time management. With a trading plan that includes a trading schedule, it is easier to keep time. It also makes it easier for allocating time to different activities as a trader. For example, time for analysis, time for trading, and time for review.
Also read: Day Trading for Beginners
Can I trade without a trading plan?
Yes, you can. However, your chances of being profitable are less compared to a trader who has a clear and defined trading plan. A trading plan helps align your thoughts, ideas, and processes to a tangible manual you can follow. This greatly increases your chances of being profitable.
What is auto trading?
This is whereby a trader uses a computer program or software to execute trades. Auto trading is especially effective for traders who scalp as it can enter into trades precisely. The computer program places the trades when the set confluences are met.
Should a trading plan be permanent?
No, a trading plan should be reviewed regularly to ensure that it suits you perfectly. Back-testing your trading plan ensures you iron out any issues or amend anything that doesn’t work anymore. It is also important to keep on updating any new strategies you have learned.